The Philippines has enjoyed a lot of success in growing its microfinance market and pursuing financial inclusion. Moreover, widening the banking base has arguably had a positive effect on the country's overall financial stability.

Financial stability and financial inclusion are the two policy issues that are foremost in the minds of regulators today. Concerns have been raised, however, that inclusiveness may undermine stability. Our experience in the Philippines suggests that the two are complementary and promote active market participation among diverse stakeholders.

The inclusion initiatives of the Bangko Sentral ng Pilipinas (BSP) are driven by our firm belief that markets must address the needs of their constituents and not the other way around. In an archipelago of 7100 islands and amid socio-economic diversity, this will be a challenge.

We know, for example, that the bottom 80% of Filipino families generate only 20% of aggregate family saving. Furthermore, only 26% of the adult population uses banking services, while 37% of municipalities do not have banking offices. For these reasons, it is not surprising that there are only three deposit accounts per five Filipinos nationwide.

The innate diversity across communities suggests that financial inclusion is about tailor-making a response for a defined problem. The objective is to enhance the financial, social and economic well being of those who are ‘excluded’. For the approach, mainstream market supervisory principles apply, but the execution is calibrated. This makes the application of regulatory requirements proportionate to the needs of constituents, generating flexibilities where rigidities would otherwise deter the creation of markets.

Filling in the gaps

The BSP pursues this strategic agenda by adhering to five operational philosophies: widening the range of products, expanding the physical network, extending the virtual reach, enhancing transparency and disclosure, and addressing potential regulatory barriers.

A wider but calibrated range of products is needed for the micro-finance ecosystem. By policy, the BSP classifies loan amounts of up to 300,000 pesos ($6772) to be within the realm of micro-enterprise, micro-agri or housing micro-finance. Complemented by such products as micro-deposits and micro-insurance, these products together address the financial needs within the micro-finance system.

Such products can only be tapped if there is commensurate access. For hard-to-reach areas, the BSP introduced micro-finance banking offices, which can provide products such as loans, savings, remittances, e-money conversion, bills payment, pay-out services and, on a limited basis, even foreign currency purchases. There is also our electronic money ecosystem. Particularly apt for an archipelagic economy, facilities for fund transfers, retail payments and partnerships with merchants are made available, bridging physical gaps in the banking network.

With products and access, the financial consumer can make better-informed decisions. Key to this will be a commitment to transparency and full disclosure.

This should be evident in market rates, since inclusion does not require any special pricing concession. To eliminate confusion, the use of the effective interest rate approach has been institutionalised. This is complemented by financial education initiatives, which are constantly instigated on a targeted basis.

None of the above will be effective, however, if specific regulatory barriers are not addressed. The intention is not to relax prudential guidelines but to balance arms-length prudential requirements against the burden of compliance. Recognising that the community has invested in inter-personal relationships, there is room to calibrate procedural requirements. This is possible, for example, in the 'know your customer' policy, which would otherwise require a face-to-face validation.

The net effect is a better-enabled environment. By the end of 2012, 187 banks in the Philippines provided micro-finance services, and we estimate that 1 million households are serviced, with an outstanding portfolio of more than 8.4bn pesos. These figures seem modest when compared to the totality of financing. Yet, as I will argue below, these figures are factually impressive from a historical standpoint.

A holistic market

With all of the above, it is natural to ask whether financial inclusion impinges upon financial stability. After all, inclusion requires specialised rules for a specialised market constituency. The fear in some quarters is that having more diverse market participants is a recipe for more information gaps. And since financial inclusion 'tailor makes' prudential guidelines for specific constituents, others are concerned that regulatory arbitrage may arise. Either of these certainly creates market pressures and this is where financial stability is a concern.

Our experience in the Philippines is that financial inclusion and financial stability are not inconsistent policy goals. We recognise that the risks in financial inclusion are transactional, of smaller value and often specific to a target constituent. But the point of taking on these risks is not to compromise governance standards but rather to calibrate the enabling environment to address to the specific needs of particular constituents.

This makes our financial system more responsive to its stakeholders who are beyond the traditional comfort zone of the bankable. Such responsiveness is anchored on regulatory flexibilities that allow for proportionate oversight where, over whom and in the manner that this is needed.

All of these are consistent with first principles. Markets are created when two parties with opposing views and different needs come together to agree to transact with each other. Markets thrive because the needs of savers versus borrowers are both serviced as well as those of depositors versus investors. When the markets are instead too fragmented and their constituents are effectively segmented, market failures could arise.

Moving forward then, it would stand to reason that financial stability would thrive when the market framework allows for the different stakeholders to participate. Financial stability can thrive when different needs are recognised, but addressed as appropriate and governed under the same overarching core principles of market governance and prudential oversight.

This is nothing more than financial inclusion. Stripped to its core, inclusion is a participatory framework that aspires for a holistic market. This breaks down barriers between bankable and unbanked, serviced and underserved. Once such a holistic market is upon us, we would have created the environment where stability is more likely to be sustained. The Philippines certainly stands by this framework.

Strength and stability

In terms of financial inclusion, we are proud of our humble achievements and the recent pronouncements from external institutions enable us to move further and forward. For four years in a row, from 2009 to 2012, the Economist Intelligence Unit’s global survey on micro-finance has ranked the Philippines number one in the world in terms of policy and regulatory framework. The World Economic Forum and other international bodies have also recognised the strides we have taken in using innovation to increase access to financial services.

In terms of financial stability, we believe that our financial system has performed well under the most difficult global conditions in recent memory. Beyond the positive review from our recent financial sector assessment programme by the International Monetary Fund and the upgrade to investment-grade status by credit rating bodies, the fact remains that the Philippine financial system has been consistently expanding throughout the past decade.

It is our view that the strength and stability of the financial system and the expansion and development of our financial inclusion programme are not merely co-incidental but rather complementary. They do not just run in silent parallel, but they run as a shared purpose.

Impressive figures

From the perspective of sheer numbers, I have already highlighted that our financial inclusion portfolio at the end of 2012 was more than 8.4bn pesos, with more than 1 million borrowers. In contrast, the portfolio was 2.6bn pesos in December 2002, serving about 390,000 borrowers.

What makes the 2012 figures impressive is not the nominal amount. Rather, it is the fact that the portfolio grew at about 12.5% per annum. When compared to overall banking system resources, growth over the same exact period was only about 8.75% per annum (from 3480bn pesos in December 2002 to 8050bn pesos in December 2012).

Though much remains to be done, we have moved forward to make economic activity much more participatory through inclusion. In the process, we have broadened the coverage of the financial net by not limiting it to those who are already naturally bankable.

The process does not end here. Financial inclusion and financial stability can and do complement each other, and we will continue to stand by this framework. Well beyond the numbers, we believe that the Filipino public is definitely better for it.

Amando Tetangco is governor of the Bangko Sentral ng Pilipinas, the central bank of the Philippines.

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